 Tests of the expectations hypothesis: resolving the anomalies when the short-term rate is the federal funds rateNo 2000-003, Working Papers from Federal Reserve Bank of St. Louis Abstract: The expectations hypothesis (EH) of the term structure plays an important role in the analysis of monetary policy, where shorter-term rates are assumed to be determined by the market?s expectation for the overnight federal funds rate. With two exceptions, tests using the effective federal funds rate as the short-term rate easily reject the EH. These exceptions are when the EH is tested over the nonborrowed reserve targeting period and when the test is performed only using data for settlement Wednesdays?the last day of bank?s reserve maintenance period. This paper argues that these exceptions are anomalous: In the former case, the failure to reject the EH occurs when economic analysis suggests that the market should be less able to forecast the federal funds rate. In the latter case, it occurs when there are sharp spikes in the funds rate that cannot improve materially the market?s ability to forecast the funds rate. Additional analysis shows that these anomalous results are a consequence of the procedure used to test the EH. Keywords: Rational expectations (Economic theory); Federal funds rate (search for similar items in EconPapers) Published in Journal of Banking and Finance, October 2005, 29(10), pp. 2541-56 Downloads: (external link) Related works: Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text Persistent link: https://EconPapers.repec.org/RePEc:fip:fedlwp:2000-003 Ordering information: This working paper can be ordered from Access Statistics for this paper More papers in Working Papers from Federal Reserve Bank of St. Louis Contact information at EDIRC. |
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